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Sunday, November 10, 2002
From last week's commentary:
"If you cannot define the risk or the reward, then you will be best served by staying cautious. We still have mix of indicators, and several are suggesting that this chop will continue. There will be spikes higher and spikes lower, but net/net we could be relatively unchanged several weeks from now."
Considering that we are within 1% of where we closed last week, with both a spike higher and a spike lower, I hope you can see the benefit of staying cautious when no clear edge is present.
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Indicator: SEASONALITY
Status: BULLISH
Comment: Last week, I discussed the positive returns November in general has had during the recent past, so I'm not going to go over that again. Monday is the 11th day of the 11th month, which is of course Veterans' Day. Although this day was originally observed as a national holiday nearly 70 years ago to commemorate the brave soldiers of World War I, and had always been recognized on November 11th, Congress in its infinite wisdom decided to change the observance to the 4th Monday in October beginning in 1968. Not surprisingly, Congress changed the recognition date back to the 11th day of the 11th month in 1978 when it became clear they had made a mistake (some things never change). In any event, November 11th has been a strong day historically for the S&P 500. Since 1950, it has been up 76% of the time, with an average return of 0.29%. Interestingly, when Congress shifted the holiday to the 4th Monday in October, the market didn't fare nearly as well. During that decade, Veterans' Day was up only 27% of the time, with an average return of (0.18%). Next Friday (or Saturday for you sticklers) is options expiration, and as is outlined on the site, the week prior to expiration has been historically positive. Since 1995, expiration week has been positive 65% of the time (compared to 56% for a random week), and Monday, Tuesday and Thursday are the most positive days of these weeks.
Bottom Line: Historically, Monday has a lot going for it, and considered in a vacuum, there is a high probability that it will finish higher than Friday.
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Indicator: RYDEX RATIOS
Status: BEARISH
Comment: I've touched on these ratios a couple of times this week, and the story remains similar today. Although the shortest-term indicator that I compute from this data (the 3-day RSI spread) has relieved its overbought nature with the late-week decline, the other more intermediate-term indicators are still in nosebleed territory. As is obvious from the Rydex Composite chart posted to the site, we have not seen this kind of asset transfer in over a year and a half. One of the reasons this flow looks so extreme is that it is reversing the extreme in the other direction that pinpointed the October low. At that point, the bullish flow was near a two-year low while the bearish flow was near a two-year high. So for the 10/50 moving average deviation indicator, for example, the 50-day ma still has the numbers for that October swoon and won't be dropping them for a couple of weeks. This makes the 10-day ma look more extreme than it would have if the asset flows into October hadn't been so lopsided into the bearish funds.
Bottom Line: All of our Rydex indicators except the shortest-term one are suggesting optimism has reached an extreme and a further market decline is likely over the coming weeks.
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Indicator: TRIN
Status: NEUTRAL
Comment: I pointed out last week that our current situation looked similar to last November, when we were entering an extended trading range. The action thus far has done nothing but reinforce the similarities. With the decline over the past two days, the NYSE and Nasdaq TRIN have recorded relatively high readings, which has served to push the 10-day averages back to neutral territory from their recent extremely overbought condition. I don't want to carry the analogy too far, but we are now at a point (on the NYSE anyway) that is very similar to the small pullback in late November 2001, which lead to a short spike up to challenge the highs, but quickly failed.
Bottom Line: The action in the TRIN indicators is eerily reminiscent of this approximate time last year, and if the similarities hold, we should remain in a trading range for at least several more weeks.
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Indicator: VIX and VXN
Status: NEUTRAL
Comment: I mentioned the extended state of the "depressed" VIX earlier this week, and that since this bear market began, each such instance had occurred within one day of a short-term high. That proved true once again, as the eighth straight day of the depressed VIX had occurred one day before the peak this week. Now that the string has been broken, and the VIX and VXN are both back to "normal", I don't see much to read from their current state.
Bottom Line: Until these indicator make another move, there's no edge to be had here.
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Indicator: COMPOSITE MODEL
Status: NEUTRAL
Comment: This model is currently in the middle of its range, which is reflective of the neutral nature of most of the indicators detailed in this commentary. Although the model has now begun to turn back up after heading down consistently since the October low, such reversals from a neutral level are not typically indicative of an intermediate-term high. Usually, the model will come much closer to one of its standard deviation bands before a move of considerable magnitude will begin. One glaring exception is the high in August, which ended with the model not far from its current level. Until more of the component indicators begin to shift to an extreme, this model will stay rangebound in neutral territory.
Bottom Line: Until we see some extremes in the other indicators, this model will not be of much help.
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Indicator: SENTIMENT SURVEYS
Status: NEUTRAL
Comment: The divergence between price and the one-year stochastics of the sentiment surveys that I mentioned last week is still in force this week, and in fact is even more pronounced. Again, the divergence is that price has made a lower high, but the sentiment surveys have, in effect, made higher highs. This means that the survey respondents are more optimistic about further price gains while price itself is not confirming the optimism. While none of the surveys are in what I would call extreme territory, the fact that this divergence is so pronounced is troubling. Perhaps the well-documented positive fourth quarter seasonality is manifesting itself in an abundance of optimism, but it's not what I would prefer to see to be confident of significantly more upside. Each of the major surveys showed an increase in bullishness during the latest reporting period, except for the Consensus poll which stayed steady at a rather high level of 45% bulls. For most of the surveys, you would have to go back six months - to the fake-out rally in May - to find the level of bullishness we have now. The German Neuer Market sentiment survey showed an interesting flip-flop between the small and institutional traders this week. Remember that the German Neuer Market is very closely correlated to the Nasdaq 100 here in the United States, so following that particular trader set can be quite useful. This week, for the period ending Thursday the 7th, there was a decrease in the neutral camp of 14% for both the small traders and institutional traders. However, for the small traders, 12% of that 14% switched to the bullish camp while only 2% decided they were bearish for the next 30 days. On the institutional side, not only did the entire 14% move to the bearish camp, but 1% even went from bullish to bearish. This has formed the most negative bullish ratio spread between the two groups since late March of this year.
Bottom Line: Even though the market averages have in general a lower high (so far), optimism as defined by the major sentiment surveys has exceeded that when price was higher. As outlined here last week, these divergences are rare and consistently bearish for the intermediate-term. We are beginning to see some evidence of small traders (usually wrong) becoming more optimistic than institutional traders (usually right). So, while the optimism expressed in these surveys hasn't reached a fever pitch, both of these developments are negative.
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Indicator: AIM MODEL
Status: NEUTRAL
Comment: The uptick in optimism this week moved this model from 53% to 49%. This puts the model within 7% of its lower standard deviation band, and is starting to become a cause for concern. It is now obvious from the chart on the site that the divergence between now and August is becoming extreme.
Bottom Line: The combination of the August-November divergence and the increasingly low relative value of the model itself is suggesting that potential upside in the broader market may be relatively muted at this point.
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Indicator: COMMITMENTS OF TRADERS
Status: NEUTRAL
Comment: A healthy rally during the most recently released reporting period encouraged the typical reaction between the small speculators and commercial traders. Namely, the small specs added to their net long position (by about 420 contracts) while the commercials added to their net shorts (by about 2,800 contracts). I say this is typical because this is how the two trader sets usually view advances - the commercial traders use them to hedge their long inventory at better prices, while the small traders try to jump on the bandwagon and ride the trend. Neither position adjustment is notably large or especially bearish. The adjustments over the past couple of weeks, however, have caused all of our stochastic indicators to move back to neutral from predominantly bullish near the October low.
Bottom Line: While the adjustments made near the October low are being unwound, we have not seen a dramatic enough move to warrant caution.
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Indicator: STEM MODEL
Status: NEUTRAL
Comment: This model tagged its bearish standard deviation band on Wednesday, and gave a good heads-up that weakness was likely in the near future. Well, the weakness was immediate and enough to bring the model back firmly into neutral. As I've stated a couple of times over the past week, the standard deviation bands have continued to drift lower, which will make it considerably easier for the model to become oversold. In fact, it will only take a reading of around 45% to be considered oversold now, as opposed to 55% just a couple of weeks ago. This suggests that any further decline will likely run into some support fairly quickly.
Bottom Line: Watch for a spike above the bullish band in this model if we return down to the lower end of the trading range in the S&P 500 and Nasdaq 100. That would create a high-odds, multi-day trade on the long side.
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Indicator: STEM.MR MODEL
Status: NEUTRAL
Comment: After a trip into negative territory on Monday, our shortest-term model spent the rest of the week in neutral. Thursday's large drop brought the model close to positive territory, but not quite there. Curiously, even though Friday was a down day, our component sentiment indicators showed an increasing amount of bullishness (bearish to us). Usually we see the opposite. While I'm not reading a whole lot into this movement, this type of action often forebodes a further move in the direction of the short-term trend, in this case down.
Bottom Line: Until an extreme is reached - or approached - it's best to not read too much into the daily fluctuations in this model.
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Indicator: PUT/CALL RATIOS
Status: NEUTRAL
Comment: On Thursday, I discussed the rare confluence we are seeing in this set of indicators, and nothing changed on Friday. Namely, both the equity and OEX put/call ratios (the 10-day averages in particular) are showing a heightened ratio of call buying as opposed to puts. Usually the equity and OEX ratios move inversely. When we have seen these ratios move lower in tandem in the past, it has lead to an extended trading range in the market. In the S&P 500 options, our put/call bid/ask bias ratio is back to neutral after being quite bearish on Tuesday and Wednesday.
Bottom Line: Add this complex of indicators to the "trading range" camp.
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Indicator: BREADTH RATIOS
Status: NEUTRAL
Comment: As has been the case for a couple of weeks now, the 10-day advance/decline and up volume ratios continue to churn away near their overbought levels. On Monday and Tuesday we will be dropping moderately oversold readings, so an early-week rally will make it quite easy for these indicators to become extremely overbought once again. However, beginning on Wednesday we will drop a string of six straight positive readings from the a/d line, for a total of +4273, making it increasing more difficult for this indicator to become overbought after Wednesday. So, either we will become overbought and stay pinned up there due to a strong rally (unlikely), or we will chop around and drift lower over the coming weeks (much more likely), which will work off the overbought condition. After becoming overbought in concert early in the week, the cumulative TICK indicators are also working off that condition and they are all currently neutral. One development to watch for this week will be the intraday cumulative TICKS, for if we rally slightly and become overbought, we may have an "overbought in a downtrend" situation which would set up a high-odds shorting opportunity.
Bottom Line: Like the put/call ratios above, add this complex of indicators to the "trading range" camp.
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Indicator: NYSE MEMBERS REPORT
Status: NEUTRAL
Comment: We're still seeing a large amount of public interest in shorting the most recent rally, which is certainly a positive. For the most recent reporting period, ending October 25th, the NYSE specialists accounted for a slightly lesser amount of short sales than they did during the previous week (which means the public accounting for a great majority of the rest of the short sales). While the amount of public shorting is not particularly heavy in a relative or absolute sense, the fact that it is not letting up to a great degree considering the market action we've had is unusual and positive. This may create a situation where if the market does not show a large decline in the coming weeks, many of these short holders will become nervous and begin to cover, creating a spike higher based mainly on short covering.
Bottom Line: Although the current level of shorting activity is neutral, the fact that it has not lessened to a great degree with a relatively large rally off the lows is positive.
I've been suggesting for weeks now that with so many of our indicators and all of the models in neutral territory, I do not see a high-odds movement in either direction. Of course, there will be spikes higher and spikes lower, but as time passes we aren't a whole lot removed from where we began. I believed that a break to the upside of the recent trading range would create a self-fulfilling short-term rally and we did get that, although it was jerky and hard to trade. In the S&P, we are still in the general vicinity of the breakout, so how the market reacts to that will be telling. If we can stay above the 900 level (and by 900, I don't necessarily mean 900 exactly, but rather the area directly above and below that level, perhaps 895-905), I believe there will be continued attempts to the upside. If not, then a retest of the lower end of the trading range is likely. In the NDX, we are still above the breakout level, but the same theory goes for that index. According to our indicators, there is not enough of a confluence to suggest that there will be a major move in any direction, so my advice continues to be to keep your longer-term positions light and not bet too aggressively on one particular direction. We will get an edge sometime soon, but it is not now.
TWO SIDE NOTES: My goal since beginning this site has been to create the most comprehensive and useful site for sentiment analysis in existence. In working towards that goal, I will soon be adding indicators and analysis of the bond and gold markets, and a few other specific sectors. Even if you don't trade these vehicles, they can add to your understanding of the equities markets. The good folks at Rydex are in the process of providing me comprehensive asset flow information for all of their funds, so this will help greatly in our analysis. Also, I wanted to give you a heads-up that I will be away from the market (and the site) during the last week in November. During that time, the site will not be updated. I understand the inconvenience of this, so I will be extending every paid subscription for the amount of time I will be away.
- Jason Goepfert